Those of us who question the wisdom of economic policies, seek to understand whether endless credit creation is always such a good idea. Governments can indeed borrow very cheaply, but private borrowers – businesses and households – usually pay more. Australian private debt is now 200% of GDP (Gross Domestic Product, a measure of the size of the economy), some four times the level of public borrowing. Does this private sector debt affect economic growth?
To answer this, it is necessary to know how much economic output is spent on interest. When I first investigated this some three years ago, I searched the literature in vain. Nobody had considered the economic effect of this expense. Therefore, I tried to build an estimate at a global level. What I found, using pre-pandemic data from 2018, was that world economic output was then around USD 80 trillion. The best figure I could calculate for interest cost was USD 17 trillion. One-fifth of economic output.
Tracing back for about forty years, interest rates paid to depositors have fallen, while real costs incurred by borrowers other than governments have risen. Real interest cost is the rate paid by borrowers minus the inflation rate, which itself is stuck at historically low levels. This cost is positive for the private sector globally, whereas some governments can borrow at less than inflation. Higher real private borrowing costs may be the reason why many economies were sluggish before the pandemic arrived.
The reasons why private borrowers face such rising costs are not hard to find:
1. Banks have incurred greater loan losses, which must be paid for by all borrowers.
2. Banks have also faced their own financial squeeze from falling deposit rates, because their net margin – the amount they earn on money taken in – has fallen.
3. Society has sought to control its banks by imposing more onerous regulations, causing the cost of compliance to further increase rates charged to borrowers.
This unrecognised private sector debt overhead, which I call the financial system limit, has now become a barrier to economic growth. There are three radical ideas underlying this concept:
a) There is indeed a limit to the growth of debt and hence to credit expansion.
b) The world is well on the way to reaching this limit.
c) Central banks have created a new, dominant economic cycle that transcends traditional economic cycles.
Every stimulus release causes a new downturn perhaps a decade later, as the costs of borrowing overwhelm the initial benefit of extra money injected into economies.
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